US unemployment falls again, the Fed is not worried about the risk of overheating, stable PMIs in China

Macro Highlights
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5/9/2018

In short

In the United States, despite the drop in the unemployment rate to 3.9% in April, its lowest level since December 2000, wage growth has remained contained at 2.6%, in line with our scenario

The Federal Reserve opted for the monetary status quo, and indicated clearly that it intends to continue its monetary tightening at a gradual pace, as we anticipated

In China, leading indicators published for April suggest a continued dynamic momentum in services

United States – underemployment has dropped and wage growth is stable, the Fed has confirmed the gradual pace of its monetary tightening

While the US employment report for March had been disappointing due to the low number of new jobs created, April was a bit more encouraging. Job creation rose slightly, the unemployment rate was down by 0.1 percentage point to 3.9%, and 91,000 marginally attached workers1 re-entered the job market in April alone. In addition, yearly wage growth was stable at 2.6%, in line with our scenario, according to which a gradual return of discouraged workers to the job market would limit upward pressure on wages.

The employment report revealed that 115,000 jobs were created in the services sector and 49,000 in the manufacturing sector in April. It nevertheless should be noted that, although job creation was lower in manufacturing, a real pick-up in employment growth in this sector has been observed since mid-2017, with year-on-year growth at 2.8% in April 2018 vs. 1.4% for the services sector. This acceleration is in line with an improvement in industrial production in the US as well as with the pick -up in business investment in machinery and equipment.

Beyond sector disparities, the employment report for April confirmed the downward trend of two key variables:

Employment growth has slowed: Despite the slight rise in new job creations to 164,000 in April, they remain below their average of Q1 2018, which was 212,000, as well as the 2017 average of 182,000. This slowdown in employment growth is in line with our scenario, and is also reflected in the surveys carried out by the Institute for Supply Management (ISM) since the start of the year, with the non-manufacturing employment index notably down from 61.6 in January to 53.6 in April.

The rate of underemployment – which groups together jobseekers, people not in the labour force but available for work, and involuntary part-time workers – has decreased, down from 8% to 7.8% in April. This drop can mainly be attributed to the return to the job market of 91,000 marginally attached workers in April, lowering the number to 1.36 million. The number of involuntary part-time workers stabilised at 5 million in April.

Implications

Despite the slowdown in employment growth in April compared to the first quarter of 2018, the number of job creations is high enough to absorb people not in the labour force2, as shown by the decline in underemployment from 8% to 7.8%.

The gradual return to the labour force of these available workers is set to limit, in the short term, overly high pressure on wages, despite the unemployment rate (down from 4% to 3.9% in April) being at its lowest level since December 2000. We thus anticipate that wage growth will remain moderate in 2018, at 2.8% on average.

The Federal Reserve (Fed) held its monetary policy meeting a few days before the publication of the employment report. At the end of the meeting, the fed funds rate was maintained at 1.75%, as we were expecting. Moreover, although no forecasts were published by the monetary policy committee (FOMC) following the meeting, and Jerome Powell did not hold a press conference (this will be the case for the meeting on 13 June), the Fed nevertheless made changes to its statement, which, according to our analysis, fully confirms that it intends to continue its monetary tightening at a gradual pace.

After acknowledging in its statement that inflation has returned to close to 2.0% (the year-on-year rise in the core PCE price index, used by the Fed to measure inflation, was up from 1.6% in February to 1.9% in March3), the FOMC indicated that it expected inflation to run near its “symmetric 2.0% objective over the medium term”.

The introduction of the term “symmetric” in the definition of its inflation target is an important modification in the Fed’s communication. According to our analysis, the Fed wished to indicate that it would tolerate inflation rising slightly and temporarily above this level of 2.0%, thereby suggesting that even though underlying inflation could rise over the coming months, this would not lead it to accelerate the pace of its rate-hike cycle.

This conclusion was moreover confirmed by the fact that the FOMC reiterated in its statement that it “expects that economic conditions will evolve in a manner that will warrant further gradual increases in the federal funds rate”, nevertheless highl ighting once again that this rate is likely to remain below its long-term levels “for some time”.

Implications

The statement published after the Fed meeting of 2 May confirms that the central bank is not worried about inflation getting out of control. The lack of strong wage growth, as revealed in the US unemployment report for April (see above), should back this analysis.

By specifying that its inflation target is “symmetric”, the Fed has suggested that, even if core inflation were to rise above 2.0% in the coming months, it does not intend to accelerate the pace of its rate hikes.

Overall, this message underpins our scenario according to which, despite the acceleration in US nominal growth that we expect, the Fed is likely to continue its monetary tightening at a gradual pace.

China – relatively stable leading indicators

In China, leading manufacturing indicators remained relatively stable in April. The official PMI thus came in at 51.4 vs. 51. 5 the previous month, while the PMI published by Caixin was at 51.1 vs. 51.0 in March. For the latter, the new export orders component recorded a contraction for the first time since November 2016, to 48.9. Conversely, the domestic orders component continues to indicate economic expansion.

Moreover, the PMI leading indicators for the services sector saw a slight rebound, which suggests a continuation of the momentum in the services industry in China. The configuration of these indicators reflects the bigger role played by total consumption in Chinese GDP growth in Q1 2018.